Subprime Auto Loans And Small Business Lending

Ty Kiisel
, ContributorI write about small business and small business financingOpinions expressed by Forbes Contributors are their own.

Every day a local car dealer screams through the radio, “A 500 credit score and a job is all it takes to get into a new car.” Don’t get me wrong, I’m all in favor of giving everyone a second chance, I just wonder if this approach is a good, long-term play. It looks like I’m not alone and has me wondering if we really learned anything from the mortgage loan debacle?

“Lenders are pulling back on extending car loans to consumers with very poor credit histories,” writes Danielle Douglas for the Washington Post, “reversing a trend that had sparked fears of a new financial bubble, according to a report released Tuesday by Moody’s Investors Service.”

Something sounds too familiar when I read, “…private-equity firms have regained their appetite for securities made up of car loans because of the cash flow and minimal risk—cars can be easily repossessed and resold,” writes Douglas. “In the face of all this demand, more lenders began making loans to would-be car buyers with low credit scores, charging them double-digit interest.”

Like Douglas, I’m concerned that Wall Street’s appetite for profits has lenders putting subprime borrowers into auto loans they really can’t afford. It doesn’t take much to make a connection to what was happening before the bottom fell out of the home mortgage business. Granted, an increase in auto loan defaults won’t do the same thing to the economy the mortgage loan crisis did, but does it make sense to make auto loans to people who really can’t afford them? Isn’t the long-term financial impact of that on the economy a negative?

I know it’s not technically the banker’s job to ensure the borrower is smart enough to know whether he or she can really afford the new car. In reality, when a new car buyer is sitting across the desk from the finance guy (or gal) in the dealership, the buyer isn’t really even talking to a “banker”—it’s someone with a vested interest in helping the salesperson get another new car sold. Without a doubt, the finance person at the dealership is looking for every opportunity to say, “yes” to the new car loan—whether or not it’s good for the buyer.

What’s the connection to small business lending?

Accessing capital is a major challenge for small business owners. It’s an even bigger challenge for small business owners who have less-than-perfect credit. Although there are more options available now than ever before to find capital to fuel business growth and create jobs, the price tag of some loan products needs to be completely understood before a business owner signs on the dotted line. Not every small business owner can afford the price tag of some of this financing.

That said, expensive doesn’t always mean bad. There are times when the expense may really be worth it. It does mean the business owner needs to know what they’re doing and what they’re getting into. Here are three considerations every small business owner should make before they jump into this type of funding with both feet.

Do you know how you’re going to use the capital? Despite what you might think, this is not a silly question. I can’t count the number of times I’ve spoken to a small business borrower who can’t articulate what he or she plans to do with the loan proceeds they’re asking for. Most of the capital available through non-bank, alternative lenders, is designed to address short-term needs and shouldn’t be considered a long-term solution for cash flow or financing growth (at least that’s my opinion). For example, some time ago I spoke with a small business owner who had just won a fairly substantial contract from the federal government and needed capital to ramp up. He was looking for a short-term loan to get his company through the first 60 days to accommodate the government’s pay cycle.

He was turned down at his local bank, but Lendio was able to connect him with an alternative lender willing to offer him a short-term loan to get over the hurdle of ramping up staff and equipment. Because he was able to access the capital quickly, paying the premium was a smart decision because he would have otherwise not been able to service the contract.

Will the extra capital have a positive impact on the business? My father believed if borrowed capital wasn’t going to have a positive impact on the business and wasn’t used to facilitate an essential business need, he didn’t borrow. If it wasn’t critical to the bottom line, he would do without until he could invest either cash flow or savings.

That’s not to say he never borrowed, he did. He just made sure it was going to add value to his company’s bottom line. This approach is even more important as the cost of borrowed capital increases.

I’m surprised at how many people when asked, “How much are you looking for,” respond with, “How much can I get.” It’s like going into the car dealership looking for a used Chevy sedan and leaving with a brand new Corvette. The burden associated with borrowed capital is significant enough that a small business owner should probably be thinking more about the smallest loan amount that will accomplish the objective—in other words, being happy with the used sedan.

Do you know the numbers? It’s critical to know what the financial reports are telling a small business owner about his or her business. I understand that most Main Street business owners don’t go into business because they’re jazzed about becoming a financial analyst, but if a business owner can’t read and understand a financial statement, a profit and loss report, or the other financial reports a bookkeeper or accountant would create, it becomes difficult to determine whether or not the business is even capable of servicing any debt.

Any CPA or accountant should be able to explain in detail (so you can understand it) what the reports are telling you. If they can’t or are unwilling to spend the time to make sure you understand, you have the wrong person.